The US dollar's recent gains have been extended, and it is having one of its best weeks since November 2016. The Dollar Index is up 1.7% for the week, as US session is about to start. Though it took this week's gains to change market's narrative, the fact of the matter, as we have pointed out is that April is the third consecutive month in which the Dollar Index fell in only one week. That translates into rising 10 of the past 13 weeks.
A combination of market positioning, such as the speculative record net long euro position in the futures market as of April 17, rising US interest rates, and diverging economic performances (data surprises indices) seemed to have spurred the move. Although in some circles, the dollar's "exorbitant privilege" may still be discussed, the US interest rate premium over Germany has never been higher. The interest rate premium over JGBs is sufficient to begin enticing Japanese asset managers to boost their unhedged allocation.
There are three drivers of the rise in US rates: Federal Reserve rate hike intentions, rising inflation expectations, and supply considerations. Suffice it is here to share three observations. First, next week there is a reasonably good chance that the core PCE deflator, the Fed's preferred measure, will reach the 2% target for the first time in around five years. Second, Treasury announces the quarterly refunding details next week. The size of each offering may increase, including the TIPS (unlike the previous quarter). Third, the market is confident of a June Fed hike and a statement next week that is more confident (hawkish hold).
The large euro option strike yesterday at $1.22 proved useful in navigating the price action. We suspect euro's sell-off provided the lens to understand Draghi rather than something Draghi said the spurred the price action. He acknowledged some disappointing data throughout the area and suggested this rather than monetary policy per se was the subject of the council's discussion. This should not have been surprising. Monetary policy is on auto-pilot until September. There is no external urgency to announce the post-September strategy, which the market has come around to expect further tapering.
Draghi stressed that the expansion remained solid and broad-based. Today's data will not disappoint. Spain and Austria reported a 0.7% expansion in Q1 ( 0.7% and 0.9% in Q4 18 respectively). France was on the low side with a mild 0.3% rise, which is probably more aligned with the trend growth than the 0.7% pace seen in Q4 17. Germany reported another decline in unemployment in April, though by the least since last June.
The UK disappointed. Most had been looking for 0.3% expansion in Q1. The risk was understood to be on the downside, but today's 0.1% report, on the back of a contraction in services in February was disappointing. Over the past week, the odds of a BOE rate hike at the May 10 meeting has been scaled back, and it has now been largely pushed back into Q3. This has weighed on sterling. Since falling below $1.40 at the start of the week, it has been unable to resurface, including the last test yesterday. It is now testing $1.38. A break of $1.37 could signal the completion of a double top pattern that would project toward $1.30, which is where sterling carved a base last October and November.
The dollar has made a higher high against the yen every day this week. In the past three sessions, the greenback stalled in front of JPY109.50. We do not see any significant options struck there, but our data is not complete. The head and shoulders bottoming pattern for the dollar that we had been monitoring targeted JPY110.
The BOJ did not surprise. By an 8-1 vote, the extraordinary policy was continued. The sole dissent continued to come from Kataoka. The BOJ dropped the reference to achieving the 2% inflation target around FY19. Kataoka wanted an explicit statement about the timing, but he had not been convinced that it would be achieved what it had projected. The BOJ's forecasts for core CPI in FY19 did not change (1.8%). It did cut this year's forecast to 1.3%.
The takeaway is that the BOJ is less confident in achieving its inflation target. It means that an exit from the extraordinary path is unlikely, and ways to make policy more sustainable may be explored. The newly arrived Deputy Governor Wakatabe did not dissent, as many had thought likely. However, the tweak in the forward guidance confirms the flexibility that we had detected privately.
The US reports its first look at Q1 GDP. The consensus is for around 2%, and if anything, after yesterday's news of a smaller than expected US trade deficit, the "whisper number" is higher. It may be, but in our reckoning, the improvement on trade was blunted by the news on inventories and shipments of durable goods orders. The main drag on the economy, why it is expected to slow from the 2.9% annualized pace in Q4 18, is consumption. The shopping sprees in Q4 saw consumption (~65%-70% of the economy) rise at a 4% annualized pace. In Q1, it is thought to have slowed considerably (to a little more than 1%). The Employment Cost Index, which measures wages and benefits (compliments average hourly earnings data in the jobs report), will be released and it is expected to confirm that despite a tightening of the labor market, there is no significant acceleration in labor costs.
The Fed can be more confident than the ECB that the loss of economic momentum is transitory. The US has as much fiscal stimulus in the pipeline as was provided during the heart of the Great Financial Crisis. Its targets are within spitting distance. Meanwhile, US corporate earnings growth has been solid, and although some of the Treasury auctions may be testing the market's appetite, longer maturities may be more attractive. Some US asset managers and banks have argued that 3% on the 10-year is an attractive yield. Yesterday's $29 bln seven-year note sale was the best received in three months.